HireQuest, Inc. (NASDAQ:HQI) Q3 2023 Earnings Call Transcript

HireQuest, Inc. (NASDAQ:HQI) Q3 2023 Earnings Call Transcript November 11, 2023

Operator: Greetings and welcome to the HireQuest Inc. Third Quarter 2023 Earnings Call. [Operator Instructions] Please note this conference is being recorded. I will now turn the conference over to your host, Mr. John Nesbett of IMS Relations. Sir, you may begin.

John Nesbett: Thank you and good afternoon, everyone. I’d like to welcome everybody to the call. Hosting the call today are HireQuest’s Chief Executive Officer, Rick Hermanns; and Chief Financial Officer, David Burnett. I’d like to take a moment to read the Safe Harbor statement. This conference call contains forward-looking statements as defined within Section 27A of the Securities Act of 1933 as amended and Section 21E of the Securities Exchange Act of 1934 as amended. These forward-looking statements and terms such as anticipate, expect, intend, may, will, should and other comparable terms, involve risks and uncertainties, because they relate to events and depend on circumstances that will occur in the future. These statements include statements regarding the intent, belief and current expectations of HireQuest and members of its management as well as the assumptions on which such statements are based.

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Prospective investors are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, including those described in HireQuest periodic reports filed with the SEC and that actual results may differ materially from those contemplated by such forward-looking statements. Except as required by federal securities law, HireQuest undertakes no obligation to update or revise forward-looking statements to reflect changed conditions. I would now like to turn the call over to the Chief Executive Officer of HireQuest, Rick Hermanns. Go ahead, Rick.

Rick Hermanns: Thank you everyone for joining today’s call. I’ll begin by providing an overview of our financial and strategic highlights from the third quarter, and then I’ll turn the call over to David, who will share more details around our third quarter results. The third quarter of 2023 was highlighted by increased revenue growth and healthy profitability primarily related to our acquisition of MRINetwork, which has driven increases in franchise royalties and underlying system-wide sales. Our total revenue in the third quarter grew 18.1% to $9.3 million, and franchise royalties increased 19.9% to $8.9 million compared to $7.4 million in the prior year period. System-wide sales for the quarter increased to $151.2 million compared to $123.2 million in the third quarter of 2022.

As mentioned, the majority of system-wide sales growth continues to be driven by our acquisition of MRINetwork with additional increased contributions from our DriverQuest and TradeCorp offerings compared to the prior period – prior year period. This growth was offset by HireQuest Direct’s relatively moderate year-over-year decline of just 5.4% and Snelling’s decline of 17.2%. SG&A expenses in the third quarter were $6.4 million compared to $2.1 million in the prior year period. The increase was primarily related to increased costs associated with workers’ compensation insurance as well as expenses to support increased system-wide sales from acquisitions and organic growth, particularly the MRINetwork. Excluding workers’ compensation and impairment of notes receivable, SG&A expenses in the quarter grew 34.1% year-over-year and represented 49.5% of total revenue compared to 43.6% of total revenue in the third quarter of 2022.

SG&A, excluding workers’ compensation and impairment of notes receivable has decreased for 2 consecutive quarters as a percentage of total revenue from 57.4% in Q1 of 2023 and 54.9% in Q2 as well as in absolute dollars. Workers’ compensation has negatively impacted our results for the last few quarters. And in this third quarter – in this third quarter, we recorded a $1.5 million expense, which is a $2.8 million net increase from the $1.3 million benefit we recorded in Q3 of 2022. Prior periods also benefited from our workers’ compensation reserve that we assumed from a 2021 acquisition, but the remaining liability there has remained relatively stable in 2023. Moving forward, we don’t expect that liability to impact year-over-year comparisons as meaningfully as in recent quarters.

Like we mentioned in the press release, there are a number of factors that have contributed to the increase in our workers’ compensation expense, some in our control, some outside of it. On a more macro level, while medical costs have been rising in recent years, workers’ compensation insurance rates have actually been declining. When combined with general wage inflation, it seems unlikely that the current relationship between workers’ compensation benefits and premiums can be sustained. Also, as we’ve grown in recent years and added franchisees, specifically to our Snelling offering, the composition of our franchisees clients and job types have shifted. We are working with our partners in this area to adjust our plans to better reflect our current business mix as well as the overall market in order to reduce the impact in the future.

However, no meaningful improvement can be expected until the second quarter of next year. SG&A expenses have also grown to support the increased system-wide sales. During Q4 of 2022, we increased our operational footprint with the acquisition of MRINetwork in additions to certain areas that support growth in our HireQuest Direct, Snelling and other temporary staffing offerings. When we announced the MRINetwork acquisition, we said we would be carrying additional costs as we integrated its operation, and that integration was largely complete at the end of the third quarter, and we believe expenses for MRINetwork are now in line with its current revenues. SG&A, excluding workers’ compensation and impairment of notes receivable was $4.6 million in this past quarter, a roughly $1 million reduction compared to Q1 of this year, which was the first full quarter after the acquisition.

Professional recruiting and staffing has some different – has different support needs to our traditional temporary labor staffing, but we expect to be able to leverage what we have today to support future growth. I said in previous quarters, M&A continues to be a key part of our growth strategy and opportunities such as our pending acquisition of TEC Staffing Services that we announced last month are part of why we have maintained operating levels, operating staff levels over the past couple of quarters. TEC’s 10 offices throughout Northwest and Central Arkansas provide light, industrial, clerical, technical and professional staffing services and generated over $34 million in revenue for the trailing 12-month period ended September 30, 2023.

TEC’s operations align well with our Snelling franchise offering and is a good example of our core acquisition strategy to acquire businesses and convert them to franchise operations. So in contrast to MRINetwork, we have the resources in place and the capacity to support the additional system-wide sales with little to no incremental expenses, thus restoring some of the operating leverage that the company has lost, as a result of the current economic environment. With that, I’ll pass it along to our CFO, David Burnett, who will provide a closer look at our third quarter results. David?

David Burnett: Thank you, Rick, and good afternoon, everyone. Thank you for joining us today. Expanding on some of the numbers Rick just mentioned, let’s start with total revenue, which for the third quarter of 2023 was $9.3 million compared to $9 million in the second quarter of 2023 and $7.8 million for the third quarter of 2022. The year-over-year increase of 18.1% is primarily due to the addition of MRINetwork. Our total revenue is made up of 2 components: franchise royalties, which is our primary source of revenue; and service revenue, which is generated from certain services and interest charge to our franchisees. We did not report any revenue from company-owned operations, although at September 30, 2023, we owned 1 location classified as held for sale and reported below the line as discontinued operations.

For continuing operations, franchise royalties for the third quarter were $8.9 million compared to $7.4 million for the same quarter last year, an increase of 19.9%. The MRINetwork accounted for $1.6 million of the increase in royalties for the third quarter as royalties from pre-existing locations had a net decrease of approximately 119,000. Underlying the growth in royalties are system-wide sales, which are not part of our revenue, but can serve as a key contextual performance indicator. System-wide sales reflect sales at all offices, including the location currently classified as discontinued. System-wide sales for the third quarter of 2023 were $151.2 million compared to $123.2 million for the same period in 2022, an increase of 22.7%. Similar to the growth in royalties, growth in system-wide sales was driven by the addition of MRINetwork, which accounted for $39.3 million of the year-over-year increase for the third quarter as combined sales from other locations decreased on a net basis by approximately $11.3 million.

Service revenue, which is generated from interest charge to our franchisees on overdue accounts receivable, service fees and other miscellaneous revenue, was $377,000 for the third quarter compared to $429,000 for the same quarter a year ago. Service revenue can fluctuate from quarter-to-quarter based on a number of factors, including changes in system-wide sales, accounts receivable, insurance renewals and similar dynamics. While there were many things in the quarter that we felt good about, including the 22.7% growth in our active customer system-wide sales and the 19.9% growth in our franchise royalty revenues, we also saw growth in our cost structure. Selling, general and administrative expenses for the third quarter of 2023 were $6.4 million compared to $2.1 million in the third quarter of 2022 and $5.6 million in the second quarter of 2023.

As Rick referenced earlier, the increase was primarily driven by workers’ compensation insurance. We had a $2.8 million swing in workers’ compensation expense. For the third quarter in 2023, workers’ compensation expense was approximately $1.5 million compared to a $1.3 million benefit in net workers’ compensation expense in the third quarter of 2022. I will just echo Rick’s remarks that the workers’ compensation carriers have struggled with interest rates in a challenging labor market, all while medical costs are rising. We have identified key components of the rate disparity as it relates to our business, and we are addressing them. From past experience, we expect it will take a few more quarters until we see meaningful improvements.

In the meantime, workers compensation expense will likely remain elevated will fluctuate quarter-to-quarter based on the mix of worker classifications, the level of payroll and claims resolution. Beyond workers’ compensation, the largest component of SG&A is employee compensation and benefits. Compensation and benefits for the third quarter of 2023 was $2.9 million versus $2.3 million in the prior year period, but below the $3.4 million in the second quarter of 2023. We initially absorbed significant personnel costs as we integrated MRINetwork into our operations. However, we are handling the integration in a disciplined manner and have made progress in controlling the impact of these costs. In addition to increased salaries and benefits, we have also incurred other MRINetwork SG&A expenses, including marketing, IT, insurance, professional fees and similar costs.

These are evident in our SG&A for the third quarter of 2023 and more so in the year-to-date results. These costs were substantially higher in the first and second quarters of 2023. The acquisition of MRINetwork came with sticky costs that reflect a slow and deliberate process. By the end of the third quarter, the incremental costs related to the MRINetwork have reached what would be an expected level based upon the current revenue volumes for executive recruiting services. The increased SG&A, particularly workers’ compensation can be felt in income from operations, which is total revenue less SG&A, depreciation and amortization. Income from operations was $2.2 million in the third quarter of 2023 versus $5.2 million in the prior year period.

Net income includes income from operations adjusted for miscellaneous items, interest, income taxes and discontinued operations. All-in net income for the quarter was $1.5 million or $0.11 per diluted share compared to net income of $4.2 million or $0.31 per diluted share in the third quarter last year. Adjusted EBITDA in the third quarter of 2023 was $3.7 million compared to $6.5 million in the third quarter last year. We believe adjusted EBITDA is a relevant non-GAAP metric for us due to the size of non-cash operating expenses running through our P&L. A detailed reconciliation of adjusted EBITDA to net income is provided in our 10-Q, which we filed this afternoon. Moving on now to the balance sheet. Our current assets at September 30, 2023, were $56.2 million compared to $51.9 million at December 31, 2022.

Current assets as of September 30, 2023, included $1.1 million of cash and $50.2 million of net accounts receivable, while current assets at December 31, 2022, included $3 million of cash and $45.3 million of net accounts receivable. Current assets exceed current liabilities by $19.1 million at September 30, 2023, versus year-end 2022 when working capital was $15.2 million. The increase in working capital was driven by the increase in accounts receivable following the acquisition of MRINetwork, offset partially by a corresponding increase on the credit line. Current liabilities were 66% of current assets at September 30, 2023, versus 70.8% of current assets at December 31, 2022. At September 30, we had $14.4 million drawn on our credit facility and another $25.9 million in availability, assuming continued covenant compliance.

We believe our credit facility provides us with flexibility and room for short-term working capital needs as well as the capacity to capitalize on potential acquisitions, including the pending transaction that Rick mentioned earlier. We have paid a regular quarterly dividend since the third quarter of 2020. Continuing that pattern, we paid a $0.06 per common share dividend on September 15, 2023, to shareholders of record as of September 1. We expect to continue to pay a dividend each quarter, subject to the Board’s discretion. With that, I will turn the call back over to Rick for some closing comments.

Rick Hermanns: Thank you, David. Despite a challenging economic environment for our industry, I’m proud of our franchisees’ performance and HireQuest’s ability to generate continued profitability. We have a long-term view of our business and looking out beyond the current economic environment and near-term increases in expenses we believe that we are well positioned to continue our record of strong performance as a leading provider of temporary workforce hiring and professional recruiting solutions. As always, I’d like to thank our employees for their hard work and dedication this quarter. And as CEO of HireQuest, I look forward to continuing to drive operational success and value for our shareholders. With that, we can now open the line to questions. Thank you.

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Q&A Session

Operator: [Operator Instructions] Thank you. Our first question is coming from Mike Baker with D.A. Davidson. Sir, your line is live.

Mike Baker: Okay. So good job on the top line and controlling what you can control. I guess maybe to me, at least, the obvious question is, is the workers comp, you gave some color on expecting that to continue. But I guess when you say continue to be elevated, and I know it’s hard to estimate, but do we think continue to be elevated at the same level, i.e., $1.5 million a quarter? And then I guess the second part of that question is, how do we think about the other costs, the $4.6 million, excluding workers comp and the impairment. Is that sort of a reasonable run rate going forward now that you’ve worked through the MRI integration? Or does that come down? In other words, how much of the MRI integration is in that, still in that $4.6 million for this quarter?

Rick Hermanns: Thanks Mike. So thanks for that question. Let me – obviously, there are two very, very important questions in there. And I guess I’ll really just to back it out even further is clearly, the quarter was impacted by 3 main factors. One, obviously, being the workers comp. And so part of the reason why we are saying, for example, no meaningful improvement will occur until basically Q2 of 2024 is because our renewal is March 1 for our workers comp program. So some of the things that we’ve identified that we need to change, like I said, we’re locked into our policy. We’re locked into our policy until March 1. The – but the other things are as far as from an elevated standpoint, our – some of them are a little bit – some of them – how can I put this?

We’re not – the reality is, and it maybe was put in a little bit. It was put in subtly. But basically, obviously, you have medical inflation that’s taking place. You have wage inflation, and yet you have workers comp rates that have dropped. Now part of it, we suspect and we think that workers comp rates can’t keep going down at a time when the cost of workers comp generally, the components obviously being indemnity benefits, which are tied to higher wages and medical costs, which, of course, are subject to a lot of medical inflation. So it’s hard for – frankly, it’s hard for me to imagine that rates won’t go back up. And to the extent that rates go back up, it assists us in then. But I have – we literally – in that area, we have literally no control.

One of the other factors that has happened to us over time is as we’ve drifted from more, let’s say, a far more heavy concentration in construction to one that’s more industrial and warehouse and professional and clerical. And this is one of the areas where we’ll definitely be working with our carriers. We’re not comfortable that, that we’ve been giving credit on our fixed cost sufficient for the fact that our claims or that are payroll has moved more towards basically less risky work. And our – and so we’re going to definitely work with them on bringing that fixed cost component down as well, just based on our sort of general risk profile. That said, the last year, our actual losses have not been – has really have been relatively speaking, worse than, let’s say, the last 30 years – not massively.

I’m not suggesting that, that’s part of it, but it was a relatively bad year. Of course, that hurts us in our argument with the carrier that they need to reduce their base key. But the net result is, as we have had a bit more of a trend towards higher overall claims. And I would add that, for example, because they become – they’re a pretty good comparison towards for us is TrueBlue, for example, I know, booked a big reserve adjustment as well for their workers comp, which would just simply say that they’re experiencing, what we’re experiencing, which then I go back to the first point of it’s hard to imagine workers comp rates generally continuing to go down at a time when claims are going up. Now that said, so year-to-date, we’re something like $4.4 million behind the prior year comparison.

How much do that do we start recovering in 2024? I’m not – I don’t think we’ll recover all of it. So I’m not – so I want to make sure everybody understands, I’m not just trying to paint a happy face on something. That said, I do think that we will make meaningful progress on bringing that back to a more normal level. So your question as far as like, do I expect it to be $1.5 million a quarter? No, I don’t expect it to be $1.5 million a quarter of cost, but whereas for the prior 3 years, it had been a benefit. I’m not expecting that – I’m not expecting that, either. As far as the other SG&A expenses, the – and as was stated in the sort of – in the presentation, the – by the end of September, we have pretty much eliminated most, I’ll say, extraneous expenses that were sort of planned as we integrated MRINetwork.